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Tractor Supply (NASDAQ:TSCO)

Q2 2013 Earnings Call

July 24, 2013 5:00 pm ET

Executives

Jennifer Milan

Gregory A. Sandfort - Chief Executive Officer, President and Director

Anthony F. Crudele - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Treasurer

Analysts

Daniel R. Wewer - Raymond James & Associates, Inc., Research Division

Justin E. Kleber - Robert W. Baird & Co. Incorporated, Research Division

John R. Lawrence - Stephens Inc., Research Division

Michael Lasser - UBS Investment Bank, Research Division

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

Austin Pauls - RBC Capital Markets, LLC, Research Division

Denise Chai - BofA Merrill Lynch, Research Division

Charles Edward Cerankosky - Northcoast Research

Jeff Black - Avondale Partners, LLC, Research Division

Christopher Horvers - JP Morgan Chase & Co, Research Division

David G. Magee - SunTrust Robinson Humphrey, Inc., Research Division

Adam H. Sindler - Deutsche Bank AG, Research Division

Aram Rubinson - Nomura Securities Co. Ltd., Research Division

Simeon Gutman - Crédit Suisse AG, Research Division

Matthew R. Nemer - Wells Fargo Securities, LLC, Research Division

Eric Bosshard - Cleveland Research Company

Operator

Good afternoon, ladies and gentlemen, and welcome to the Tractor Supply Company's Conference Call to discuss Second Quarter 2013 Results. [Operator Instructions] Please be advised that reproduction of this call, in whole or in part, is not permitted without prior written authorization of Tractor Supply Company. And as a reminder, ladies and gentlemen, this conference is being recorded.

I would now like to introduce your host for today's conference, Ms. Jennifer Milan of FTI Consulting. Please go ahead.

Jennifer Milan

Thank you, operator. Good afternoon, everyone, and thank you for joining us. Before we begin, let me take a moment to reference the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. This conference call may contain forward-looking statements that are subject to significant risks and uncertainties, including the future operating and financial performance of the company. Although the company believes that the expectations reflected in its forward-looking statements are reasonable, it can give no assurance that such expectations or any of its forward-looking statements will prove to be correct. Important risk factors that could cause actual results to differ materially from those reflected in the forward-looking statements are included in the company's filings with the Securities and Exchange Commission. The information contained in this call is accurate only as of the date discussed. Investors should not assume that the statements will remain operative at a later time.

Lastly, Tractor Supply Company undertakes no obligation to update any information discussed in this call.

Now I'm pleased to introduce Greg Sandfort, President and Chief Executive Officer. Greg, please go ahead.

Gregory A. Sandfort

Thank you, Jen, and good afternoon, everyone. Thank you, all, for joining us on today's call. With me today is our CFO, Tony Crudele.

We are delighted with our results and our level of execution in the second quarter. Despite a late start to spring with cooler weather early in the quarter, our team made the necessary adjustments to address those shifts, while delivering improvement in sales and operating profitability.

Our performance in the first half of 2013 demonstrates the continued strength and stability of our core business model.

At Tractor Supply, we continue to focus on our sales driving and margin-enhancing strategic initiatives and through our expansion of our exclusive brand offerings, better localization of our assortments and the improvements in our supply chain capabilities, we are increasing our market share and improving our profitability as a company.

Our previous call in late April, we discussed that the second quarter had started with much cooler weather and as we had anticipated. We experienced a slower sales ramp in the spring. We adjusted our plans accordingly for this shift, and although we felt we did not recapture as much as the postponed spring seasonal sales from the first quarter as we would have liked, we are pleased with our team's ability to deliver strong comparable store sales increases over a year ago.

While certain big-ticket seasonal products such as riding lawnmowers did not rebound as we had hoped, we experienced very strong sales trends in our C.U.E. categories, our new live goods and garden products, poultry as a category and apparel and footwear. More importantly, our teams managed our seasonal products effectively, and we finished the quarter well-positioned with current high-quality inventory as we enter the back half of the year.

Now let me discuss our second quarter results in a bit more detail. Regarding sales drivers. Our C.U.E. categories, the consumable, usable and edible part of our business, remain very strong. These are need-based items that are driving repeat footsteps into our stores.

The repair and maintenance parts business for outdoor power equipment, a C.U.E. category, has trended above last year's sales levels, reinforcing the behavior that our customers are repairing their products to extend their life versus replacing them.

C.U.E. remains a foundational piece of our sales driving strategies, and we work diligently every day to enhance and expand these products to meet the changing needs of our customers.

Another strategic area of focus for us is driving sales in our drive aisle and center court areas, where we strive to maximize sales per square foot. We utilize this space to host special events and to introduce new and seasonally appropriate products.

This is not only -- this not only enhances our customer shopping experience and expands the overall size of the customers market basket, but it also signals to our merchant teams what products our customers have the most interest in purchasing as we build forward assortments.

One such event was our Garden event, which provided our customers with a selection of new products and great everyday values on seasonal commodities such as seed, soil and fertilizers.

Additionally, we hosted a poultry event during the same period labeled Chick days. During this event, we provided our customers with a wide array of items related to raising poultry. Both of these planned events performed well, delivering results above the prior year.

Our introduction of newness into our stores utilizing our test and learn approach continues to gain momentum.

One great example is our Live Goods Program, which we began testing about 3 years ago. In this category, we expanded our assortments of bedding plants, vegetables, seedlings, herbs and fruit-bearing trees. Our customers have responded well to our offerings and we are very optimistic about the potential for further expansion of this business over time.

Our exclusive brands continued to exhibit growth during the second quarter and accounted for roughly 29% of our sales mix. Exclusive brands are an important differentiator for Tractor Supply and a key initiative in driving increased footsteps, customer loyalty and improved profitability.

During the second quarter, we continued the expansion of our 4health exclusive brand dog food through the introduction of grain-free products. Customer response has been very positive. This is an expansion of our Super Premium assortments, which continues to be one of the fastest-growing segments in our pet food category.

We also added several other new products to our pet health department with similar positive responses from our customers.

So to summarize, I am delighted with the team's ability to manage through the numerous variables and seasonal shifts we faced during the quarter. The diligent work of our teams both at store level and at the Store Support Center was exceptional, resulting in solid comparable store sales, transaction count improvement and another quarter of double-digit growth and profitability.

I will now turn the call over to Tony to review our financial results and discuss our outlook for the remainder of 2013.

Anthony F. Crudele

Great. Thanks, Greg, and good afternoon, everyone. For the quarter ended June 29, 2013, on a year-over-year basis, net sales increased 12.7% to $1.46 billion, and net income grew by approximately 15.9% to $123.6 million or $1.75 per diluted share.

Comp store sales increased 7.2% for the second quarter compared to last year's increase of 3.2%.

As Greg discussed, although there was much later start to the spring this year, spring did finally come and, correspondingly, drove solid sales performance.

Although we believe we did not recapture all the postponed seasonal sales from the first quarter as a result of the delayed spring, we did plan for the seasonal shift between quarters and managed accordingly to deliver strong performance for the second quarter and the first half, overall.

The animal and pet categories continue to be the main drivers of our business with strong comps that were above the chain average, seasonal category such as live goods, certain gardening categories, outdoor recreation and rubber footwear all performed well above company average for the quarter and the season.

Comp transaction count increased for the 21st consecutive quarter, gaining 4.8% on top of a 2.9% increase last year.

With the delayed spring and the continued strength of feed and pet products, C.U.E. products, which serve our customers basic and functional needs, continue to be the key driver of the transaction count increase.

Average comp ticket increased by 2.3% versus last year's 11-basis point increase. The increase was driven by inflation and mix, and to a lesser extent, big-ticket sales.

A few key points about the quarter. Despite the slow start to the quarter, sales were consistent with our expectations. Adjusting for the $38 million pull forward of sales into the first quarter from the second quarter last year, comparable sales to this year would be very consistent for each quarter in the first half with a year-to-date comp of 4.2%.

On a regional basis, our warmer regions performed the best as they were the least impacted by the delayed spring weather and all regions generated positive comp sales.

As we had anticipated, April was the softness month of the quarter, with May delivering the strongest comp store sales gain. All 3 months achieved solid positive comp sales.

Big-ticket delivered a solid comp sales increase, but was below the chain average.

For the quarter, we did have a comp sales increase in the riding lawnmower category, which resulted principally from the weather-related sales shift between quarters compared to last year.

For the overall season, the riding lawnmower industry continues to be sluggish, which was reflective of our first half performance in that category.

We estimate that inflation was approximately 140 basis points and was within our projected range of 1% to 2% for the full year.

Import sales increased 25% and represented 10.8% of the sales mix. Exclusive brand sales also increased by almost 25% and represented 29% of total sales.

Turning to gross margin, which as a percent of sales, decreased by 18 basis points to 34.8%. This was consistent with our outlook as we anticipated the gross margin will be flat to slightly down in the first half of the year.

Our initial direct margin continues to improve significantly as a result of our initiatives around price optimization, markdown management and strategic sourcing.

The largest factor offsetting the benefits from our margin-enhancing initiatives was merchandise mix, which we estimate had a negative impact of approximately 40 basis points. This was primarily related to C.U.E. products, which continue to make up a larger percentage of our sales compared to prior year.

We continue to manage gross margin dollars per unit, which again increased in our C.U.E. categories this quarter.

Freight increased approximately 16 basis points principally as a result of the continued mix shift to freight-intensive C.U.E. products, as well as costs related to increased import activity.

We also opened a smaller percentage of new stores relative to the total store base in the first half of this year compared to the last year. We estimate that this had a negative impact on gross margin in the quarter of approximately 10 basis points, as new stores generally run a stronger margin.

For the quarter, SG&A, including depreciation and amortization, was 21.2% of sales, reflecting 63 basis points of improvement from the prior year's quarter.

As we have discussed in the past, although our increasing mix of C.U.E. sales impacts gross margin rate, it also provides us with an increasing sales base that allows greater leverage of SG&A expenses.

We continue to effectively manage and leverage store level operating expenses. Even in light of a very strong sales quarter, our incentive compensation program provided 13 basis points of leverage.

We are particularly pleased with our ability to leverage SG&A despite the additional costs related to our DC and data center relocations, which we estimate negatively impacted EPS by approximately $0.02 for the second quarter.

Our effective income tax rate increased to 37.4% in Q2 compared to 37.2% last year. The increase was due principally to higher effective state tax rates and reduced federal tax credits, as well as a smaller percentage of incentive stock option disqualifications relative to a higher taxable income base.

Turning to the balance sheet. At the end of Q2, we had a cash balance of $56 million compared to $179.1 million last year.

During the second quarter, under our stock repurchase program, we acquired approximately 177,000 shares for $19.4 million. Our stock performed very well during the quarter, which limited the purchases under our matrixed 10b-5 plan. We estimate that the share repurchase program did not have a material impact on EPS for the quarter.

Average inventory levels per store at quarter end were 4.7% higher than last year, while annualized inventory turns increased by 10 basis points and 3 basis points for the quarter and year-to-date, respectively.

We are pleased with the productivity of inventory during the quarter despite later inventory carry in a number of spring categories related to the later extended spring season this year.

Additionally, we shifted some Q3 receipts to the end of the second quarter this year and also carried additional inventory to support the transition to our new Southeast distribution center, both of which contributed to our higher inventory levels at quarter end.

Overall, we do not anticipate any markdown exposure in Q3 outside of our normal clearance activity. In fact, we believe we are in better position than last year to clear our spring inventories productively given our improved inventory turns, as well as improved moisture levels and fewer drought-affected regions relative to last year.

Capital expenditures for the quarter were $49.3 million compared to $33.8 million last year. We opened 26 stores this quarter compared to 18 stores in the second quarter of 2012. The increase in capital spend relates to the construction of our relocated Southeast distribution center and the construction of our new Store Support Center.

Turning our attention to the full year outlook. As a result of our stronger-than-expected operating performance in the first half, we are increasing our net income expectation for the full year 2013.

We now expect net income to be in the range of $309 million to $315 million or $4.36 to $4.44 per diluted share.

This compares to our previous guidance of $304 million to $310 million or $4.32 to $4.40 per diluted share.

We now expect full year sales to range between $5.1 billion and $5.17 billion compared to our previous expectation of $5.07 billion to $5.17 billion.

Correspondingly, same store sales for the year are expected to increase 4% to 5% to our prior expectation for an increase of 3% to 5%.

Based on the volume of our share repurchase program year-to-date, we are also adjusting our estimate for full year diluted shares outstanding to approximately 70.9 million.

While we do not see any changes to our estimated range for capital expenditures of $240 million to $250 million, we are turning at the lower end of the range. The new store pipeline is full and we continue to track very well to our full year goal of 100 to 105 new stores.

Inflation is tracked as expected and we continue to estimate that it will be approximately 1% to 2% for the full year, with the back half projected to be in the 0.5% to 1.5% range as we begin to cycle the high corn prices from a year ago.

With respect to margins for the full year, we continue to expect to achieve slight gross margin rate improvement through the execution of our key gross margin initiatives.

Also, we believe we have easier comparisons to the clearance activity we experienced last year, and we'll also be citing some emergency response activity in Q4 last year related to Hurricane Sandy.

We expected that the mix shift to our C.U.E. products, which carry a margin rate below chain average will continue to present a headwind, but should start to moderate slightly.

We also expect freight cost to remain a headwind due primarily to the continued mix shift to the more freight-intensive C.U.E. products, as well as increased import container volume.

With respect to SG&A, we expect to have a drag in the second half of the year of approximately $5 million to $6 million or $0.04 to $0.05 in EPS related to the relocation of our Southeast distribution center and our corporate data center, which for the most part will be expensed in SG&A in Q3.

We also saw an uptick in our medical and other fringe benefit expense trend line and had forecasted larger increase in the back half of the year.

As a result of the impact of the DC and data center branches and the fringe benefit increase, we expect to have a flat to very slight SG&A leverage in the back half of the year.

Based on the above discussion, we anticipate that our target EBIT margin improvement will be driven more by gross margin rate improvement than by SG&A leverage in the back half of the year.

For the full year, we are increasing our forecast effective tax rate to 36.7% from our previous guidance of 36.5%. The increase relates to the higher effective state tax rates and a smaller percentage of incentive stock option disqualifications relative to a higher taxable income base this year.

So to conclude, we again executed very well in the second quarter despite a slower start to the quarter than we would have liked. The core business is very strong and we saw seasonal sales accelerate as the weather warmed, producing solid financial results for the first half overall and positioning Tractor Supply for a healthy summer selling season.

So with that, I'd like to turn the call back over to Greg.

Gregory A. Sandfort

Thank you, Tony. Regarding the current retail environment, we have seen relatively no change from recent quarters with the behavior of our customers.

They continue to purchase conservatively, seeking compelling values based upon need rather than want. They continue to adapt our assortments to meet their changing needs while continually elevating our in-store experience.

Before I close, I would like to provide an update on a few of our company's current initiatives.

Our new distribution center in Macon, Georgia, which is the relocation of our Southeastern distribution center in Braselton, Georgia is now complete and operational.

The facility is currently receiving inventory and we expect to begin shipping to stores from this location later in the third quarter.

Construction of our new Store Support Center in Brentwood, Tennessee, which will enable us to consolidate our 3 leased Store Support Center locations into 1 owned facility that will accommodate our growth for many years is on track, and the project is scheduled for completion in the back half of 2014.

The functionality enhancements to our website continue, and while there is still much more to do, we are encouraged with our results thus far. We have completed the upgrades to our website for drop shipments of products from vendors to customers, our Franklin, DC is functioning well as our online in-house fulfillment center, and we are adding more SKUs each quarter to expand both the breadth and the depth of our product offerings.

Our annual square footage growth continues at approximately 8% as we further expand into the West. We now have a number of stores open in the West, and we see more growth for this region over time.

We currently operate stores in Arizona, Colorado, New Mexico and California and soon-to-be operating our first stores in Wyoming and Nevada.

Looking forward to the second half of the year, I am confident about our plans and the forward momentum we have as a company. We are executing at a high-level, making continued progress on our sales driving and operating margin enhancing initiatives, and we are regularly introducing product newness into all our stores to ensure our customers stay highly engaged with the Tractor Supply brand.

In closing, I would like to thank all of our Tractor Supply team members for their ongoing hard work, passion for our customers and commitment to our company, with special recognition to all our Oklahoma team members impacted by or helping those impacted by the recent tornadoes. Our team members are the driving force behind Tractor Supply's growth, and we all look forward to a successful second half of 2013.

Operator, I would now like to open the call for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from Dan Wewer with Raymond James.

Daniel R. Wewer - Raymond James & Associates, Inc., Research Division

Greg, in 5 of the past 7 quarters, gross margin rate has been flat or slightly lower. I know that you're expecting margin to improve during the second half of the year, but do you think that we're possibly at the point where the future of significant gains in gross margins maybe unwise and perhaps it's best to start returning some of those efficiencies to customers to drive market share?

Gregory A. Sandfort

Dan, great question. Let me answer it this way. The mix of our business continues to shift, in a positive way, to C.U.E., which is the foot drivers of our customer base, and really it's kind of the basis of how we structure the company, about probably back in '08 and '09 when we made some changes to some of these assortments. Gross margin rate, just a straight topic conversation, it's something that shifts between quarter based upon not only mix, but other factors and other valuables. As Tony mentioned in his comments, our direct margin is actually increasing at a very nice rate, and that's the positive side of gross margin. We're still fighting have some headwinds with freight, we're still fighting some headwinds with overall mix. We believe we'll start to normalize more of that as we get in the third and fourth quarter, as we cycle through. And I believe we have a better handle on what's happening now as we go forward. But I would agree with you that the steep incline that we've seen, maybe in the past 3 to 4 years, may not be the same as we go forward. We still are confident though we can still get the 20 basis points or so as we said each year. And remember, our new operating margin goal is still targeted at 10.5%.

Daniel R. Wewer - Raymond James & Associates, Inc., Research Division

Right. And then just a follow-up question for Tony on the new store growth, the square footage. It looks like square footage is up about 7.3% year-over-year. In your prepared comments, you noted that it would probably wind up the year at around 8% growth. Could you discuss why the store openings, I guess, are somewhat back loaded and how that might impact your expenses in the second half of the year?

Anthony F. Crudele

Sure. You're absolutely correct, the first half grew a little bit slower than we had originally anticipated. Some of it has to do with the wet weather and pushing back some of the stores. Some of it has to do with, obviously, some lease negotiations that pushed out some of our deals. We do anticipate easily hitting our number, of the 100 to 105, and they will be a little bit more back loaded into the October and even, potentially November timeframe. From an expense standpoint, when it comes to the preopening, those cost has been relatively flat with last year, so you, again, from a model standpoint, can predict those. And as I noted in my comments, in the first half of the year, by opening up fewer stores on a percentage basis, it has a slight impact on margin. We would expect in the back half that would help margins slightly.

Operator

And we'll take our next question from Peter Benedict with Robert Baird.

Justin E. Kleber - Robert W. Baird & Co. Incorporated, Research Division

It's actually Justin Kleber on for Pete. First for Greg, just on the traffic number. Obviously, another strong number here. Can you guys maybe just discuss the frequency of your average shopper or how that's evolved and changed over the past few years? Is the visitation gap between your best and maybe your average customer becoming wider? Or do you think it's narrowing?

Gregory A. Sandfort

Great question, Justin. And we typically don't talk to some of those specifics. What we can tell you is that, the number of trips that the consumer seems to be making to our store is growing. It's more consistent than it was in the past. And I think it ties us up around the C.U.E. strategy. These are consumable, usable, edible, necessary items, and as long as we can keep the customer engaged there, and I also will tell you, I think it's a gain of market share across many of those categories. We become that most dependable supplier of, that's what's driving it. So we've got some statistics. We do track our best customers at the very high-end of the scale and what I'd call probably our more moderate customer usage, and we're seeing more footsteps clearly.

Justin E. Kleber - Robert W. Baird & Co. Incorporated, Research Division

Okay, that's great. And then Tony just some clarification on the guidance. So it looks like the earnings grew by 18% in the first half of the year, on comps slightly over 4%. Your second half guidance seems to imply a comp of at least 4%, but the earnings growth looks to be about 13% at the midpoint. So is that deceleration simply the DC or data center cost and the health care issue you noted? Or is there something else that we should be aware of? Because I would've thought the inflection in gross margin you're expecting would offset some of those headwinds in the second half?

Anthony F. Crudele

Yes, you're correct. The margin does -- the gross margin does offset some of the SG&A expense, but the real pull back or headwind is the anticipated cost of transitioning to full operations on the distribution center and then the subsequent relocation of our data center. And one of the big driving numbers is we're just going to be running duplicate rent for both of those locations until the end of the year. So we'll be able to cycle some of those costs as we move into next year.

Justin E. Kleber - Robert W. Baird & Co. Incorporated, Research Division

Okay. So that rent, is that included in that $0.04 to $0.05 that you called out or is that...

Anthony F. Crudele

Yes, it is. That's included, as well as there's a temporary labor that's included and there's, obviously, some handling and movement of product between the former DC, the lease location and the new location. And -- so those are really the largest expenses.

Operator

And we'll go next to John Lawrence with Stephens.

John R. Lawrence - Stephens Inc., Research Division

Greg, would you comment just a little bit? You mentioned recently a lot about regional assortments. Would you talk a little bit about that and the program of how much of these stores are now getting inventory regionally versus from other methods?

Gregory A. Sandfort

John, we have become a little bit maybe more refined than just talking about regional. We're really talking now about local, localization is really our new moniker, if you would want to call it that, and it's because as we move into different parts of the country, stores that are -- I'll give you an example, stores that are in the mountainous region versus stores that are may be in the valley, maybe in the same state, but they act very differently, the needs are very different. So I had mentioned before that we have about 600 plus different types of assortments out there on our stores based upon the locations and the regionalization. But we've not taken a step further, John. And we're now really looking at the local level, a lot more input from the management teams in the field, and we still have a lot of work to do, but we do our homework before we go into a new area of the country and we are understanding the needs of that market much better. So a lot of work there. A lot of assortment planning and planogramming work that's done well in advance to those stores' opening.

John R. Lawrence - Stephens Inc., Research Division

Great. And secondly, left-hand side of the store, tools, et cetera. I know you've doing a lot of work there last several years. Anything to update there that's going on?

Gregory A. Sandfort

Well, if you've been in our stores recently, you'll note that we are expanding what we call the hardware set and we're revamping it, but we're making some moves to shift product categories around, place the new products into that area and we are -- this year, we'll be moving several hundred stores into that new format. We've tested it for a few years now, we're happy with the results and you will see the left-hand side changing a bit, and the whole hard lines component still having seasonal toward the front and then placing the hardware component in a little different setting, if you may call it, and we've also done some work in the back there within the automotive and truck and tool. So that's kind of continues to get worked.

John R. Lawrence - Stephens Inc., Research Division

Great. Last question on cross dock on the feed. Any update there in Texas?

Gregory A. Sandfort

The current test is complete. We're very happy with the results and we are currently beginning a process of trying to locate a facility in the same region to actually start to roll this process forward.

Operator

We'll take our next question from Michael Lasser with UBS.

Michael Lasser - UBS Investment Bank, Research Division

First on the gross margin side. I think last quarter you had 65 basis points of pressure from the mixed shift to C.U.E. This quarter, it was 40 basis points and you have the gross -- overall gross margin degradation was about the same. Can you connect those 2 points? Did you see less of a benefit this quarter from some of your gross margin initiatives?

Anthony F. Crudele

Michael, this is Tony. We saw actually about the same increase when it came to the direct margin piece, but there's obviously so many other variables as far as the way as we look at margin internally. So I highlighted the larger pieces, in particular, the sort of the impact that we get from the new stores and also the way we manage markdowns during a particular quarter. And then some of the programs that we put together with our vendors. So that all comes into play and can impact a particular quarter. But from a standpoint of our initiatives, they are really driving a very strong initial direct margin on the products that we're bringing in now. So we're very pleased with how that is working. And truly just of sort of relates negative or the degradation really is a result of the mix of the product.

Michael Lasser - UBS Investment Bank, Research Division

Do the rate of improvement from -- on the direct side were similar in the second quarter to what it was in the first quarter?

Anthony F. Crudele

Correct. It's very -- strong performance. As we look out, we're anticipating that the headwind that we do get from the C.U.E. items should start to moderate and should decrease slightly.

Michael Lasser - UBS Investment Bank, Research Division

And why is that?

Anthony F. Crudele

Well one, as we cycle some of the higher cost from last year. And then with the anticipation that some of the pricing will come down in some of the feed categories, in particular. You have opportunity to be able to better manage the rate. So in escalating prices, in times of escalating prices, we'll manage, as we've talked in the past, to try to get a certain dollar per bag or dollar per unit as we go through lower inflation or potentially deflation in some categories, we'll still manage to that same dollar per unit, but that dollar per unit now returns you a higher margin rate. So we believe the degradation that we'll get from that headwind will be a little bit less or start to moderate in the back half.

Michael Lasser - UBS Investment Bank, Research Division

And then my last question on that point. We've seen some volatility in commodity prices, grain prices, corn prices, what sort of impact is that having on your customer? And what have assumed about that into the back half of the year?

Anthony F. Crudele

Yes. There has been some volatility, some of it has been more conversation than actual actualization. So it's been a little bit more steady than you would suspect. As we look into the back half, like I just previously mentioned, we do expect some of the prices to be lesser than they were last year, although we have yet to see that sort of precipitous decrease in any of the particular grains that we deal with. And as I've stated previously, we would expect that, that would benefit margin rate in the back half of the year.

Michael Lasser - UBS Investment Bank, Research Division

So will it have an impact on your -- the amount of income that your customers are going to have, such that they may have less to spend in your stores?

Anthony F. Crudele

It's possibility, but right now, we don't anticipate it having a significant impact. Obviously, we'll have to work through that as we see the environment and the economy in the back half of the year. But as we've said in the past, it generally has more a trickle-down effect into the economies that we deal with in the Midwest, tends to be a little bit more isolated and generally would not have a significant impact.

Operator

We'll take our next question from Matthew Fassler with Goldman Sachs.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

One cleanup question to start with. You talked about the investment from the DC relocations, et cetera, then the expansions in the second half of the year. Did you give that number for the second quarter?

Anthony F. Crudele

Yes. It was about $0.02 impact on EPS.

Matthew J. Fassler - Goldman Sachs Group Inc., Research Division

Got it. That's helpful. And then secondly, if you could just comment on essentially what you saw in June? Obviously, April was a challenging month given the later start to spring. We heard a lot about precipitation in June in certain parts of the country. What impact did that have on your business in the quarter and how does that set you up -- how does that influence the set up for Q3?

Anthony F. Crudele

Well, as I had said in my comments, all 3 months were strong comps relative to, obviously, the overall quarter. And so that's the detail that we provide for June. The other thing that I would comment on is that, we believe that this year, there has been more moisture. We believe that also, when it comes to drought, it is much more isolated and it's isolated more in sort of the Southwest area of the country. And last year, it extended much more into the Midwest. So we believe that the weather conditions do provide for a little bit more extended spring/summer selling season. So we think that, that bodes well, obviously, for the June performance, as well as into some of the July performance. Now, also as an editorial, I would say that any type of spring performance does start to moderate significantly as we move into July and the August timeframe. So it becomes a much lesser portion of our sales.

Operator

And we'll go next to Austin Pauls with RBC Capital Markets.

Austin Pauls - RBC Capital Markets, LLC, Research Division

I have a couple of high-level questions on the topics of market share and competition. With respect to some of the bigger box national retailers that maybe don't focus solely on the farm and ranch segment that you do, but do have some overlap with you guys in certain product categories. Are there any signs on those retailers are seeing these strong sales growth that you have been putting up? And have any interest in expanding their assortments in those areas? And then secondly, with respect to some of your smaller more regional competitors that do focus on your core real customer, are you seeing any actions from those companies on market share, whether it's more competitive pricing or potentially even increasing their own new store growth plans?

Gregory A. Sandfort

Let me start with that first. This is Greg. Interest or signs of interest from the large box retailers that may sit around us. On occasion, we will see one of the or several of these guys that will get in to some of the businesses in a small way looking at it as a potential, I believe, potential foot driver for them. The difference is that, we're in this businesses to stay and our customers understand about Tractor Supply. So if someone else would want to jump in and jump out of the business, that doesn't make you an authority. And I think over the long haul, what we see is that customers continue to come back to us. We have not had anyone that we can tell as far as our core customer base would be moving to a big box or something like that to buy some of these products because they really don't have the expertise to talk to them and to really sell them to the consumer. The second piece about regionals. Some of the regionals, when we move in to their markets, have a tendency to do believe that it's about price. And our belief is it's about a better store, a better assortment in that store and it's about a good -- great customer experience along with a fair price. Most of them compete on a high-low basis. We do not. We compete on an everyday price basis with some promotion. So they have a tendency to try to play the price game. We will, in many cases, play the match game for a period of time. But in the overall scheme of things, we tend to win that battle and I'll also tell you that in some instances, as our growth of store base has expanded, many of what I'll call the smaller independents, who are specialty retailers in either feed, maybe it's a pet operation, maybe it's a tack operation, maybe it's something that is just in 3-point equipment. We have a tendency to be that store that can draw that consumer to one location and make the purchase versus having to go to multiple locations. So we somewhat, I guess, outman them from a standpoint of our assortments having a one-stop shop. So a number of factors, we continue to run our game and play our game and we continue to improve what we do, and I think we'll continue to win.

Operator

And we'll go next to Denise Chai with Bank of America Merrill Lynch.

Denise Chai - BofA Merrill Lynch, Research Division

Could you talk a little bit about some of your progress in newer markets like Colorado, where you've been operating now for a bit over a year? Any early learnings? What do you see some of the key differences from your core markets in terms of the customers and also the competitive environment?

Gregory A. Sandfort

This is Greg. I'll speak to that. We studied the Colorado market and we'll study any new market for a period of time before we'll open our first store. And what we found was that the consumer was being underserved in some aspects that there was some requirements that were expected of us if we were going to compete with those independents. And that will be the points of differentiation that we could exploit versus what that competitor originally was doing. And that's a little bit of a simplification of how we go about it, but we have had great success in Colorado and in a number of other states as we've expanded because of using that formula.

Denise Chai - BofA Merrill Lynch, Research Division

Okay, great. And going back to your 25% growth in exclusives. Could you talk about what categories are driving this. And I saw that you're advertising your expanded paint and tools assortment. Is this another opportunity to put more exclusives into the stores?

Gregory A. Sandfort

The exclusive brand categories are growing for several reasons. One is we're offering the customer a far better value equation for their hard earned money. Secondly, there are always gaps in anyone's assortment that can't be filled by a national brand, so we're able to use our exclusive brand to fill those gaps. And I would say third, across the store, we're finding opportunities, but we don't try to force those opportunities. We test them first, let our customers respond. If they give us the positive response to allow us to take it to the next category, the next extension of products, we'll do that, and that's worked for us. We've been successful at this point and that will be our plan going forward.

Operator

And we'll take our next question from Chuck Cerankosky with Northcoast Research.

Charles Edward Cerankosky - Northcoast Research

As you look at new store openings, any change in the real estate market out there? Any sense that supply is tightening or cost of sites is going up, things of that nature?

Anthony F. Crudele

Yes. Chuck, Tony. We have seen that some of the rents have been increasing very modest, and it has not impacted our ability to identify locations and/or to obtain a very -- the required return that we would expect to get out of our new stores.

Charles Edward Cerankosky - Northcoast Research

Do you cover that increased strength and the pricing of that individual location? Or is it sort of the overall pricing of the chain?

Anthony F. Crudele

It's going to vary from state to state. So we're going to see different prices in the various states. And generally, we're going to cover that through the increased sales level that we would anticipate gaining from that particular marketplace. So as an economy rebounds, if the rents rebound, we'll generally going to be able to drive some additional sales volume that would easily cover any additional rent expense that we would have to manage.

Charles Edward Cerankosky - Northcoast Research

Okay. And somebody earlier might have said this, but I want to get a clarification. Did you say the new store mix in the most recent quarter skewed to a somewhat lower size?

Anthony F. Crudele

No. I would not say that. We opened a few less stores in the first half of the year relative to the prior year.

Operator

And we'll take our next question from Jeff Black with Avondale Partners.

Jeff Black - Avondale Partners, LLC, Research Division

Just to sharpen an earlier point. Your gross margin guidance for the second half, is that premised on C.U.E. lessening as a headwind from the 40 basis points? Or is it premised on the margin initiatives you're working on kind of offsetting, in total, the C.U.E. headwind? And then on the inventory, you mentioned that we had some more carryover, but you think there's less margin risk to the carry over. Could you just clarify what's really going on with the inventory build, at least, from the 2 C.U.E. step with left over aspect?

Gregory A. Sandfort

Yes, Jeff, I'll take the inventory. I will let Tony talk a little bit about the gross margin. At the end of the quarter, we had already planned to have 2 facilities operating, Braselton and Macon. So we'd already indicated that there was going to be some carry of inventory, basically duplication of inventory for a period of time as we ended the quarter because we still would not be fully transitioned to Macon. So that was some of the dollars. Some of the dollars were also an investment piece that we made as we saw the quarter start to open up with sales. We said let's get ahead of it, and let's make sure that we keep the C.U.E. categories, driving businesses as they were, so we made some, I will call it, inventory investment forward, to make sure that we stayed in the stock positions we wanted. And then the last piece was something to do with -- at the end of the quarter, we had some early receipts of third quarter that actually came in about, let's say, a week early by the end of the quarter, that shifted in. That was probably the largest impact overall for the quarter. That's all forward inventory. It just arrived to about a week earlier than we would have liked, to be very honest. But the way we booked our inventories, if it's been picked up and it's in transit, it's going to get under the books. So that was the larger portion of it. But we're in great shape for our transmission out in spring into summer and fall.

Anthony F. Crudele

When it comes to gross margin guidance in the back half, as I have noted in the comments, we think we're up against easier compares. As Greg just mentioned, we like where we are relative to our inventory position. So we believe that as we go into the spring clearance mode, we'll be able to manage those markdowns effectively. We obviously, in the back half of the year, also are going up some emergency response from Sandy, so that last year carried a lower margin. So we believe that, that's an easier compare as well. We'll be opening up a lot of new stores in the back half that could have a slight positive impact. And then, in addition to seeing some of the impact of lower prices in some of the grains, we would anticipate that the headwind from the rate impact on margin could moderate as well, as well as the mix starting to moderate as well. So a lot of different factors affecting the back half. Obviously, I wanted to make it clear that we really expect to have some gross margin momentum in the back half that we had not experienced in the first half. And then with that additional charge for the DC and the data center impacting SG&A, the back half just -- will act a little bit differently than what we saw in the first half. I just want to make that clear to everybody.

Operator

We'll take our next question from Chris Horvers with JPMorgan.

Christopher Horvers - JP Morgan Chase & Co, Research Division

Following up on the inflation question. You still expect about 100 bps in the back half on inflation. So is that the chemical business driving a positive move in the food category? It seems more like disinflation? And related to that can you talk about the inflation outlook in maybe the horse side versus the dog side in the food category.

Anthony F. Crudele

Yes. We would anticipate that -- I mean, there's so many different categories, we're looking at over 340 different categories and they all react a little bit differently. So it's hard to isolate. We don't have anything that we're seeing that had a significant increase to it. So we're probably looking at very modest increase across the majority of the categories. And where we see sort of that offset to bring it down from what we experienced in the first half, really, is more on sort of the grain side of the business in the animal feed. So that's why we think it will be a little bit less as we look at the back half of the year.

Christopher Horvers - JP Morgan Chase & Co, Research Division

Understood. And you would include the dog, cat -- dog food in there as well?

Anthony F. Crudele

No, we look at the pet food side as, generally, being flat in the back half of the year.

Christopher Horvers - JP Morgan Chase & Co, Research Division

Understood. And then on the live goods, can you talk about how many stores that you had live goods in during the spring season where compared to last year? And how you think about the number of stores that you can and want to get that into? And do you think, eventually down the road, there is a garden center perhaps on the side of the store using up some of the yard?

Gregory A. Sandfort

Chris, this is Greg. First of all, we had limited stores in 2012. We were still going through some more testing. This year, we had an excess of 500 stores with live product. I would tell you that, we're finding that side lot, if you want to call it, which is now our area for storage, can be productive if we can place the right products there. So I won't give you an absolute on the fact that, that's where live goods may wind up and will there be a garden center there. But I will tell you that we're pleased with the results. We're still looking at how we would position the business for next year if we take it to more stores in the chain. It's a business that has to be run regionally. So we have to have the availability of the product and the growers there to be able to service it. But we do believe there's future growth in that category.

Operator

We'll take our next question from David Magee with SunTrust Robinson Humphrey.

David G. Magee - SunTrust Robinson Humphrey, Inc., Research Division

A couple of questions. Is it possible to assess what the longer-term penetration would be at the C.U.E. category? Is that something that you think will be growing rapidly throughout next year or how do you assess that?

Gregory A. Sandfort

Well, Dave, as you know it's a number of different categories. It's not just feed, food, or whatever. There's a multiple things that we have classified under C.U.E. It's really the products that we would consider would be footstep drivers and what I would consider to be the most dependable supplier of -- these are the items that customers can count on when they come to our store. Now, its overall penetration, in many ways, is growing because we are gaining market share from -- I'm going to say others around us and we're running a much more powerful business, a business that is well priced day in and day out, with our new price optimization modeling, we're able to do that. And I can't tell you today if there's a percentage or not. I can only tell you that we see further growth as we go forward, but we also saw it becoming more of a run rate of where we've been. And at this point, we're happy with it because it is bringing a lot of footsteps. You saw that with over 4% increase in transaction count. The customer should continue to come to us. Over time, that gives them the opportunity to shop other places within our store and that's where we can build more margin. So there will be a balancing act as we go through the next couple of years.

David G. Magee - SunTrust Robinson Humphrey, Inc., Research Division

Okay. And secondly, with the enhancements that you're making to the e-commerce site, any update with regard to your thinking on the ultimate profitability of that business and perhaps a penetration there too?

Gregory A. Sandfort

Well, even some of the most developed retailer out there that have websites, they're doing sub 3% and 4% of their overall business on the web. In my thought process about the web, it's first, just another vehicle for us to exchange either commerce information or just exchange commentary with a consumer. It's a way for us to understand what they're purchasing from us and why and how we can go back to them and talk to them about things they're interested in. The commerce side of this is a little longer term from a standpoint of its ramp and its run, because you have to have a number of things, I said earlier in my prepared comments about having capabilities. But we do believe that there'll be some business for us longer-term, but I believe what it does, it drives just -- it probably drives more business for our stores than it will probably drive online by a great margin. So the store business, we're a 4-wall retailer in this is just another way for us to exchange commerce, I believe, with the consumer. And I'm going to tell you that, we will not be probably anymore than some of the best at retail today as far as percent of overall sales.

Operator

And we'll take our next question from Adam Sindler with Deutsche Bank.

Adam H. Sindler - Deutsche Bank AG, Research Division

Sorry to go back to gross margins again, but just when we're talking about the back half of the year. Really the comparison is not easy in the fourth quarter. It's not too much lower than what we saw in the second quarter. You're up 80 last year. In second quarter, you're up 50. On the run rate, in the second quarter this year, you're probably about plus 50, plus 80 and then minus 20 or something like that, plus 60. As we look to the back half of the year, is most of that improvement going to be weighted to the third quarter? And then sort of, for the year, how are you looking at gross margins? Are we looking flat for the year, are we looking slightly up? What would you say about that?

Anthony F. Crudele

As we look at the back half, we do see a lot -- we see a lot of the opportunity in Q3. But as we move into Q4, the one thing about Q4 is that, it is a lot of import activity. So we have a potential of driving some gross margin improvement there. The new stores that we opened in the back half of the year are weighted towards the fourth quarter as well. And then we always believe that we can go through the season more effective as far as managing the markdowns. We are hopeful that it will be a little bit colder in December and that will provide us the ability to manage through the holiday season some of our, obviously, insulated and cold weather products. So yes, we definitely recognize that it is a tough comparison as we move into the fourth quarter, but we believe that there are some variables that we can be able to react and drive margin improvement in both the third and fourth quarter.

Adam H. Sindler - Deutsche Bank AG, Research Division

Okay. On the merchandise outlook, obviously, live goods was very successful for you guys in summertime this year. Any sort of new tests you're working on for the winter?

Gregory A. Sandfort

Adam, there's always new tests. I've always said there's 40 to 50 ongoing. Yes, we'll have -- we will bring -- continue to bring newness to the stores. We'll continue to have testing, but I'm really not at liberty to tell you the specifics. I can only tell you, go visit our stores, you'll find it.

Operator

And we'll take our next question from Aram Rubinson with Nomura.

Aram Rubinson - Nomura Securities Co. Ltd., Research Division

A lot of questions have been asked, so I'll focus my attention on CRM. I know you guys have been working hard on understanding the makeup of your customer more over time. Can you tell us a little bit more about what you've learned so far. Specifically, I'm interested in the distribution of kind of customer and visits and your best customers representing x percent of sales. I was wondering if you can give any inklings there. And then I have a follow-up.

Gregory A. Sandfort

Let me give you some insight. This is Greg. We are spending quite a bit of time on understanding our consumer, and we have developed a 5-year roadmap, which we are now in the initial stages of starting to roll into that plan. The first thing we understood we got to do was pull all of our data together on our customers. And we have it in a number of, I'll call it, buckets here in the company. So we're doing that merge right now. Once we have that information, we'll be able to start talking to this customer and looking and cross-referencing as they buy 1 category, are they buying another category? And if they're not buying into that category, why aren't they and so on and so forth. And we have some current learnings through some of the initial merge of some of the information. We actually use that in the middle part of this year, during the July 4 period. We did change some distribution using that information and we had very, very positive results. So we know the power of it. The matter of fact is we have to start to harness that. So that's going to take some time, but we do have a very rigorous process we put into place. We are in the first stages and now doing that, first consolidation, and we'll be able to share more with you as time develops.

Aram Rubinson - Nomura Securities Co. Ltd., Research Division

And if I can just follow up in the absence of kind of science on the CRM side, you've got kind of art, which testing and experimentation. And some of those tests are working and some of are not working. So if we can use that as a proxy for CRM. Can you tell us about where you see your bandwidth with customers? Where do you see them kind of -- are there any obscure tests that are succeeding are any obvious wins that are failing? Just curious kind of where you're getting permission from that customer and kind of roughly shortcomings in that regard too?

Gregory A. Sandfort

What I can tell you is that in some of our current learnings, we were spending some time, about a year ago, talking about the aware non-shopper. And we weren't sure if this was a suburban or if this was a more suburban rural type of consumer that lived out on the edge. I can tell you what we found out in our current research is they actually live much closer to the store than we thought. These are these customer that don't shop us, but would have an interest to shop us if they understood what was inside the box. So that's just one segment of a number of things that we have learned, how we're going to market them will be different, how we will attract them to the store will be different than our core customers who already know us and who already spend money with us. But it's exciting news, and I'm very anxious to get more of this information and to take this data and convert it into information that we can use across the company.

Operator

We'll take our next question from Simeon Gutman with Crédit Suisse.

Simeon Gutman - Crédit Suisse AG, Research Division

Greg, on price optimization, I think in the past we've talked about 4 phases or 4 components to it. I think promotional being the second bucket, and I think if I've got it right, that's kind of where the company is at or starting to pursue. Can you put some time frame parameters around it? And then I'm not sure if 1 bucket of price optimization is more opportunistic than others, but where this one stands relative to others?

Gregory A. Sandfort

Well, first, let me set you straight on this price op, we're in the regular price component today, continuing to learn, continuing to refine. The second bucket is really around clearance, because it's the other component of our business. Since we do have some seasonal categories, we'll move the clearance next. Third, and the most difficult will be promotion, because we're not a highly promotional company and when we do run promotion, whether it be something in preprint or on the Internet or with a coupon or whatever, there's a lot of variables there. So that, really, is the most difficult. We will -- we are looking forward into 2014 to start to work in the clearance bucket. And there's no exact timing yet because there's still some system upgrades we'll need to do, but it looks like we'll continue to stay with Revionics and we'll be looking at the end of 2014.

Simeon Gutman - Crédit Suisse AG, Research Division

Okay. And then just a quick one for Tony. You mentioned the incentive comp program that it provided leverage. Was that because of the program design? Or is it because, I think in the comments, that sales you expected to be a little bit stronger and maybe some of those numbers just weren't hit.

Anthony F. Crudele

No. It's really generally how the program is designed each year as we go into the year and put forth what we believe are fairly aggressive targets both on a sales and an operating level for our team members out in the stores. We should be able to benefit from the incentive compensation program. This year is a little unique because of the way the sales fell last year versus this year and we had such a strong first quarter and how we level out the incentive compensation. But coming into this quarter, being a fairly strong sales quarter with the shift relative to last year, we did expect the incentive compensation to increase relative to sales level, which it did. But again, with the more aggressive targets we come in with at the beginning of the year, still provide us the opportunity to leverage that program.

Simeon Gutman - Crédit Suisse AG, Research Division

And if I can just clarify, I mean if the business does a 7% comp, let's say, in the future. Does the program -- is the program designed to provide leverage?

Anthony F. Crudele

At a 7% comp year-over-year, you'll probably have very limited leverage from the incentive compensation. There's a combination, you have to look at both pieces, one is the store piece and then one is the Store Support Center. Over a course of the year, at 7%, it will provide leverage because at a store support level -- Store Support Center level, the incentive compensation is capped at a particular point. So net-net, overall, you should get some leverage at a 7% comp, and it's designed where the shareholder will benefit from a strong selling season.

Operator

And we'll go next to Matt Nemer with Wells Fargo Securities.

Matthew R. Nemer - Wells Fargo Securities, LLC, Research Division

I just have one quick follow-up. Your account payables days are starting to stretch again after a long period of some compression. Has there ever been a change in philosophy around AP timing? Or is this more of a product mix issue? And what impact could that have on the gross margin rate going forward?

Anthony F. Crudele

Yes, Matt. There hasn't really been a change in the philosophy. We obviously try to be as aggressive as possible when it comes to the accounts payable and the payment terms. What you see is -- included in the accounts payable is not only just merchandise payables, but also expense payables. Some of what you're seeing is timing. You also see, as we sort of lap versus last year, a little bit more consistency in that build because they're more comparable periods. Last year was a difficult comparison because we had added the extra week from the 53rd week before. So they weren't really apples-to-apples comparison. As we go through this year, there will be some spikes as we go through and we see quicker turns on some of our C.U.E. items that generally will hold back the accounts payable and we will not be able to get the leverage that we like to get out of the accounts payable. But to the basis of your question, there has not been a significant either philosophical approach or change the way the accounts payable is managed.

Operator

And we'll go next to Eric Bosshard with Cleveland Research.

Eric Bosshard - Cleveland Research Company

The increased or slightly increased sales guidance for the year, can you just talk a little bit what is within that, if that's market or market share growth or if there's anything within specific categories that's contributing to that?

Anthony F. Crudele

Yes, Eric. It really relates to the strength of the C.U.E. product and the performance of the C.U.E. throughout the first half of the year. So the majority of the sales driver is related to what we believe has been sales above expectations for the first half. And then to certain extent, a little bit lesser extent, the back half relative to the trend that we've seen when it comes to the performance of the base functional C.U.E. items.

Eric Bosshard - Cleveland Research Company

And is that -- the C.U.E. category growing faster? Are you gaining incremental share? And if it's share, are there specific areas where you feel like you're making the most progress?

Anthony F. Crudele

No. We're definitely at the combination of increased trips from our current consumer, as well as additional market share.

Operator

And there are no other questions at this time. I'd like to turn the conference back over to our speakers for any closing remarks.

Gregory A. Sandfort

Okay. Thank you, operator. As you can see, we're very passionate about our business and the opportunities that's still are ahead of us. We will continue to focus on our strategies to drive sales and grow operating profits. Thank you, all, for your continued interest and support of Tractor Supply Company, and we all look forward to reporting third quarter results in about 90 days.

Operator

Thank you, everyone. That does conclude today's conference. We thank you for your participation.

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